Unless your adviser is fee-conscious and thorough, how much
you are paying for your mutual funds might never be raised.

“Investing is a strange business. It’s the only one we know of where the more expensive the products get, the more customers want to buy them,” wrote Anthony Gallea and William Patalon, authors of the classic 1998 book Contrarian Investing.

The authors were referring to the fact that investors are eager to buy a stock or commodity as the price rises (gold over the past two years) and equally eager to sell as it falls (RIM, of late). They were also referring to how investors believe that if they pay higher fees for mutual fund management, they will get better service and make more money.

But research shows those fees (management expense ratios or MERs) steadily erode your bottom line. Not only that, there is no correlation between higher fees and better fund performance.

In Canada we suffer some of the highest mutual fund fees in the world. Worse, those fees are largely hidden, as they rarely appear on statements. Unless your adviser is particularly fee-conscious and thorough, how much you are paying for your mutual funds might never be raised.

Exchange Traded Funds (ETFs) are an excellent choice for investors because they have tiny fees and aim to do nothing more than track a given index. But many advisers can’t offer them to consumers because ETFs are listed like stocks and advisers need a broker’s license to sell them to clients. Other advisers won’t recommend them because there are no sales commissions or ongoing trailer fees as there are with mutual funds.

Do-it-yourselfers may be attracted to ETFs but the trading fees can mount up if you are buying them monthly or even quarterly.

Happily there is a lower fee alternative for investors — index mutual funds. These funds are passive, i.e. they simply track or mimic a stock market index. Because there is no buying and selling, i.e. active management, the fees are much lower than other mutual funds.

Last week I wrote about five index mutual funds that are good choices for the Canadian equity portion of your RRSP or other investment portfolio. There are also index mutual funds for bond and U.S. index investments.

I ran a screen to find no-load U.S. index mutual funds with MERs under 1 per cent and a minimum investment of $100 or less (after an initial investment.)

The TD e-version fund is only available if you have a TD Canada Trust account. Otherwise the higher fee TD Index Currency Neutral can be purchased from any brokerage.

All the funds track or mimic the S&P 500 Index except for the Altamira U.S. Index and the TD Dow Jones Average, which tracks the Dow Jones industrial average. Also, you’ll note the currency neutral phrase; it indicates the funds are hedged to eliminate the currency factor.

There is considerable debate about whether or not currency hedging is a good idea. Expert opinion (and research) seems to indicate that hedging, when one currency is involved like the greenback or the Euro, eliminates volatility and produces a better result over time (bear in mind that most of the research I examined was done prior to the big loonie run up.)

All the funds listed do offer a non-hedged version with a different (usually lower) MER.

On the bond front, the pickings are slimmer for index mutual funds but I came up with four low-fee options.

As with the U.S. index mutual funds, the TD e-version is only available for those with TD Canada Trust investment accounts. The TD funds track the DEX Universe Bond Index and the Scotia fund tracks the Scotia Capital Universe Bond Index. Both are broad Canadian indices with a mix of government and investment-grade corporate bonds.

The RBC fund tracks a Canadian federal government index and the yield will be somewhat lower over time than funds that include corporate bonds — but the risks are also somewhat lower.

Most investors will be perfectly well served selecting one Canadian index mutual fund (from last week), one U.S. fund and one of the bond funds. With just three investments you are well diversified at a very reasonable cost.

However, human nature being what it is, we always want more. So next week I will finish the series with some international and specialty index mutual funds.

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